is this bad idea? negative cashflow with equity loan

14 Replies

a newbie here. I'm interested in buying a rental investment property. My brother started his investment 2 years ago and he's doing pretty good. He has recommended to take the equity loan as much as I can from my first house and make smallest possible down payment on the 2nd house. His logic is that if I get comfortable with being a landlord, I will have extra liquid cash in the bank to buy 3rd house for rental. He says if I use up the cash, I will have to take another loan down the road.

So here is the data:
- equity on the 1st house is about 100k
- I'm looking at buying the 2nd house for around 350K
- I have good credit score around 790
- I have saving of $40,000

Based on the calculation, I will break even with my cash flow if I make 25% down payment on the 2nd house. If I do 80/15/5, I will deplete ~ $400 every month, but I'll have over 100k usable cash.

I'm not sure whether to make big down payment to minimize the monthly cash bleeding or keep the cash as much as I can in the bank for 3rd house. Or meet some where in the middle?

I'd appreciate any thoughts/feedback.

If you're looking to landlord and want to keep this 2nd house for a long time then you should consider which deal is going to give you the best long-term profit. 9 times out of 10 the best deal is going to be a single fixed-rate loan with no pre-payment penalties. Not only that, but one of the main reasons for being a landlord is the extra monthly income, NOT the extra monthly expenses!

The only reason to do the 80/15/5 at this point is if the profit you'll make on the second deal is astronomical. If it's just an average profit then you're just throwing money out the window. If it's below average then don't even think about doing it with the 80/15/5!

On the other hand... if you're just trying to flip the rehab / 2nd property then you want to have as much cash on hand to do the project. So in this case the 80/15/5 makes more sense... but it only makes sense if the rehab is going to net you a boatload of money!!!

You are in this business to make a profit.
You are in this business to make a profit.
You are in this business to make a profit.

While it isn't always easy to calculate... your goal is always to make as much profit as possible. If you're doing that then there will always be a way to get the financing for that next hot deal.

Thanks for the feedback juzamjedi,

What's your definition of "long term" and why the fixed rate would be better than 80/215/5 for long term?

By long term I mean 15-30 years... lenders tend to charge higher rates for 100% financed homes and that is especially true for long terms. Interest rates are a combination of macro factors (fed funds rate, value of the dollar, etc.) and micro factors (loan term, loan-to-value ratio, FICO, etc.).

Your situation:
If memory serves you were going to get the $100,000 by dipping into equity of your 1st home. I assume you mean your personal residence? If this is the case I would suggest you forget this idea entirely. Personally speaking, I will not put my personal residence on the line for my business because I always want that security blanket. I can take calculated risks, but my personal residence is where I draw the line. How would you feel if a business (RE investment) caused you to lose your personal residence? Could you recover from something like that both financially and emotionally? For me the answer is probably yes to the first and no to the second... so I just don't dip into my personal residence. :protest:

If by 1st home you meant you would liquidate your first investment property... or if you're just more open to risk than I am... then go through the exercise below:

Short, short version:
You can get $100,000 at the cost of interest payments on the 15/5 loans. Can you make more money than that by keeping it for yourself?

Think of this another way...

If you take the 80/15/5 then you have $100,000 at a cost of <insert present value of 15/5 interest payments here>. If you can take that $100,000 and plunk it into another property that earns a profit that is higher than this cost then you're making a smart business decision.

Or...

You can take the $100,000 and pay it towards the purchase of the new home. This will give you a guaranteed return of <insert present value of 15/5 interest payments here>. Not only that, but it reduces your overall risk by reducing monthly payments and improves cash flow.

I realize after re-reading my answer that I never said exactly what I would do...

In my area, with the deals that are available to me, I would take the $100,000 from my investment property and re-invest it somewhere else. Then again I get deals with good positive cash flow. :mrgreen: If I was looking at negative cash flow then I'd probably look for a new deal...

15 will be the line of credit at fixed rate option at 7.3% I'm not planning on using that. In my situation, 80/15/5 is a better deal after considering PMI tax if I were to do single 95 with 5% down payment.

I meant the house I'm leaving in when I said 1st house. Yeah, so you are right. I'm getting my personal property involved. But like I said, I'm going to try my darnest not to touch it.

I know you want positive cashflow, but is that a golden rule of REI? I mean did everyone start off with positive cashflow? I don't think it's ever possible with the house market I'm interested in. I'm not interested in out-of-state investment. I want my first rental property to be nearby.

What market are you working in? San Francisco? :violin:

Are foreclosures sold for close to market value?
Is rehabbing an option in your area?
Are there new housing developments that you can get in on?
Different types of real estate will offer different rates of return (even in a bloated area)... condos might have hit a ceiling, but perhaps multi-units can be found for a bargain?
And of course different neighborhoods can make a big difference. In the suburbs of Dayton you can't find a double / multi unit for a price where you'll make positive cash flow, but if you go into a pocket on the north side of town then you can make a killing.

This is Seattle area.

I have a full time job and I don't want to go into rehabbing. I have no idea how to go about foreclosures. Don't you need the entire purchase price in cash to buy foreclosure? Man, I sound so clueless.

WHOA, WHOA, WHOA.

Do you KNOW what the term CASH FLOW, even means?

You're planning on putting $25% down payment on a $350K house to get a "break even" deal. That deal isn't BREAK EVEN, it's a NEGATIVE $87K from day one! This is the kind of (capital has no cost) idiotic mentally that drove the former Soviet Union into bankruptcy.

If someone told you that "break even" is a good deal you should run away from them. I've been investing for almost 30 years and there's a long list of things that happen to properties that "breaking even" can't pay for. Such inevitables as:

Vacancies
Paint
Carpet
Roofs
Countertops
Landscaping
Advertising
etc.

There is only ONE REASON to invest in residential real estate, and that is POSITIVE CASH FLOW. Negative cash flow such as you are describing is SPECULATION, it's NOT INVESTING.

all cash

thanks for the encouragement... I guess :wink:

How can you say the 25% downpayment is negative? You are not losing it, it's still there!

He's talking about CASH FLOW, not EQUITY!!!

From an EQUITY point of view you're right that's it "still there".

From a CASH FLOW point of view it's all gone!!! Cash out of your bank account = negative CASH FLOW!!!

Both of these factors are very important, but you need positive cash flow to make real estate work long term. As all cash has already said... the only reason to do a negative cash flow deal is in the hopes of cashing in on a high resale value of the home QUICKLY. That's what we call speculation (because you're betting that someone else will be the "bigger fool" and pay a premium price on the house you're buying). If you're making positive cash flow then you can hold on to the property (forever?) and then resell whenever the price is right.

Good advice here...

Although you didn't state it, I would suspect that you are talking about the asking price being 'right in there' with what the FMV is for the area. Herein lies the problem for you...

I am near a housing market where folks are buying rental properties where they are paying MORE than the rents can support the debt service...and the rents may never catch up to the price of these properties. So they have a NEGATIVE cash flow to start with.

Okay, so maybe the properties will appreciate in value? Great...but if these mulit-units are not going to be bought by people looking at turning them into single family homes...not happening in my area...then the only interested investors would be those that could get a positive cash flow from them, right? Sounds like a 'last guy through the door' exit strategy...very, very dangerous.

didnt take time to read every reply, bue pleeeaaaassse....

take that 100k out of your 1st house immediately and do something with it. Why let the bank control 100k of your money?? it amazes me how many people have mega equity in there house because they think its the best thing to do.

Because business is business and personal is personal.

If your business is seperated from your personal life (and IMHO it should be) then you wouldn't want to mix your personal assets in with your business assets. Why worry about losing your personal residence? Cut down on that stress.

All Cash- Like always, while rough around the edges, your advice is sound and appreciated, haha :)

TMR- please elaborate.

I've got about 60k in equity in my house. my area, before the boom, had a strong history of 5.5-8%/year equity gains on residential homes. this is not a 5 year history, i'm talking decades. So what is wrong with letting the investment of my equity stay unscathed in the world of 'debt free' while making the modest, yet much better than bonds/CD's, etc. 6+% ROI?

If your home wasn't appreciating, and it were as easy as simply pulling $100k from your home, and investing it somewhere then I would understand and agree. But after you pull that money using (i'm assuming) an equity loan, your return on investment must be pretty high in offset the interest you are now paying the bank to use 'your' money.

nextsean-

I'm from Seattle too. if you are still watching this thread.... I haven't yet seen anyone translate 'cash flow' in this manor, so if someone feels I'm misleading, please correct + explain. But a lot of people have a hard time grasping the concept.

Consider your down payment and monthly payments on your rental the 'cost' of your 'product or service'. and your product or service of course, being rent. to have positive cash flow/profits, you need to sell your product for more than it costs you each month.

with the down payments you are considering, I think you'd do better looking further south, towards Tacoma, or maybe south King County if you perfer (although Enumclaw I think is more inflated than other So. King County cities). Or Kent. a high metropolitan type area with lots of jobs and people who will pay good rent, yet where houses are still less expensive... will result in better cash flow, IMO..

good luck

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